Exemptions in Chapter 7 Bankruptcy

When considering filing for Chapter 7 bankruptcy, the first thing most people want to know is how much property they’re allowed to keep. The answer largely depends on the type of property you have, how much that property is worth, and the bankruptcy "exemptions" that you can use. Read on to learn more about exemptions and the role they play in your Chapter 7 bankruptcy.

(To learn how Chapter 7 bankruptcy works, see the Chapter 7 Bankruptcy area.)

Exemptions in Chapter 7 Bankruptcy

When you file a Chapter 7 bankruptcy, a bankruptcy trustee is appointed and given the authority to sell your assets to pay your creditors. However, filing for bankruptcy doesn’t mean that you have to give up all of your property.

Bankruptcy exemptions allow you to keep a certain amount of property so that you can make a fresh start after the bankruptcy. In a Chapter 7 bankruptcy, if you can exempt an asset, the bankruptcy trustee cannot sell it to pay your creditors. How much property you can keep in a Chapter 7 bankruptcy will depend on the value of your assets and the exemptions you can claim. Thanks to exemptions, most Chapter 7 filers keep all or most of their property.

How Much Am I Allowed to Exempt?

The amount of property you can protect in Chapter 7 bankruptcy will depend on the state in which you live. Each state has a set of exemptions. Most states require you to use the state exemptions while others give you a choice between the state system and the federal exemption scheme.

The federal system and most states allow you to keep a certain amount of equity in your house and your personal property, such as a car, many retirement accounts, and some wages (although relatively few states allow you to exempt much cash). Also, no matter where you live your household goods and clothing are usually exempt unless they are unusually valuable.

See Bankruptcy Exemptions by State for state-specific exemption amounts.

What Is the Bankruptcy Estate?

All of the property you own when you file for bankruptcy, except for most pensions and educational trusts, become part of what is known as the estate when you file for bankruptcy. For instance, the following assets will be part of your bankruptcy estate:

• property in your possession
• property in someone else’s possession (such as an item you’ve loaned to a friend)
• property you’ve recently given away
• property you haven’t yet received but are entitled to
• proceeds from your property (such as rental income or dividends)
• certain assets you receive within 180 days after filing (for example, an inheritance or lottery winnings), and
• your share of marital property.

The bankruptcy trustee will assume control of the property in the bankruptcy estate throughout your case. What will happen to it in Chapter 7 bankruptcy will depend on whether you can protect it with an exemption.

How Do Exemptions Work In Chapter 7 Bankruptcy?

When you complete your bankruptcy paperwork, you’ll list all of your property and any exemption that you can claim for each item. If the exemption covers the property entirely, you’ll be able to keep it. By contrast, the trustee will be able to sell any property not covered by an exemption and distribute the proceeds to your creditors.

But sometimes it can be more complicated. The exemption might partially cover the property. Or, you could have a secured debt, such as a car payment or mortgage. In that case, the creditor’s lien on the property ensures that the creditor gets paid first.

Here’s how it works.

Suppose that your car is worth $10,000 and your state allows you to exempt $5,000 in vehicle equity. Your outstanding car loan is $5,000. The trustee must pay the lender $5,000, leaving equity of $5,000. Because the bankruptcy exemption would protect all of the vehicle equity, the bankruptcy trustee would not sell the car.

If, however, your state only allows a $2,000 car exemption, then the trustee could sell your car and do the following with the proceeds:

• pay the lender $5,000
• pay you the $2,000 exemption amount
• pay sales fees and costs out of the remaining $3,000, and
• distribute any remainder to other creditors.

If the exemption scheme you’re using has a wildcard exemption—an exemption you can apply to any property—you can use it in addition to the vehicle exemption to protect more vehicle equity. (Learn more about the Wildcard Exemption in Bankruptcy.)

When the Trustee Abandons Property

Even if you can’t fully exempt an asset, the trustee might still choose to abandon it (decide not to take it) if liquidating it won’t net a worthwhile payment to creditors. This usually happens when the property value is only slightly greater than the exemption amount after taking into account the costs and fees associated with selling the asset. If the trustee abandons the property, you get to keep it.

Buying Property From the Bankruptcy Estate

If you’re unable to exempt property that you’d like to keep, the bankruptcy trustee might agree to allow you to purchase it at a discount (the value of the asset minus the costs and fees related to the sale). You’ll need to demonstrate that you’re using funds that aren't a part of the bankruptcy estate, such as post-filing wages, or a loan from a family member or friend.